Prepared for the Government of Newfoundland and Labrador

Transcription

1 Study of Homeowner, Commercial Property, Liability, and Marine Insurance Prepared for the Government of MERCER OLIVER WYMAN ACTUARIAL CONSULTING, LTD. April 2004

2 Addendum Please note on Page 52 under the heading Oil Tanks the statement but that it does not require inspection and registration of oil tanks until March 2007 applies to existing oil tanks only. All new oil tanks require inspection and registration effective the date the regulations came into effect, April 2002.

3 Contents 1. Introduction Background Study Scope, Caveats, And Limitations The Insurance Products That Are The Subject of This Study Affordability And Availability Hard Market The Situation in Historical Profitability of Homeowners Insurance, Commercial Property Insurance, Commercial Liability Insurance, and Marine Insurance Complaint Log Discussion with the Insurance Brokers Association of Newfoundland (IBAN) Insurance Company Operations within the Province Insurance Regulation Goals of Insurance Regulation How Government Regulates Insurance Pros and Cons of Insurance Regulation Ways to Address Availability and Affordability Problems Residual Market Mechanisms Additional Risk Spreading Mechanisms Other Ways to Deal With Affordability or Availability Problems Recommendations Conclusions Recommendations as Respects Rates Recommendations as Affordability and Availability Issues Recommendations Regarding Rate Regulation Other Recommendations Appendix Definition of Key Terms Appendix Exhibits. 60 i

4 CHAPTER 1 Introduction 1.1 Background The Government of (the Government) retained Mercer Oliver Wyman Actuarial Consulting, Ltd. (Mercer) for actuarial consulting assistance related to homeowner insurance, commercial property insurance, commercial liability insurance, and marine insurance. The Government is concerned about the affordability and availability of these insurance products, which are important to the financial well being of individuals and businesses in the province. Specifically, we were asked to conduct a study to address the following: Review the history of the profitability of these insurance products in the province over the past five years. Comment on the reasonableness of the profits realized by insurance companies, as identified above. Comment on whether insurance companies operate reasonably within the province in accepting risks for these insurance products, in relation to their profitability. Recommend ways to ensure that these insurance products are available to the public, including the feasibility of a risk sharing pool. Make recommendations regarding the feasibility of regulating rates for these insurance products. 1

5 The principal research and findings of our analysis are contained in the following sections of this report, which should be read sequentially. CHAPTER 1 INTRODUCTION Section Background Section Study Scope, Caveats, and Limitations - This section contains information that should be fully understood before taking action on any findings or recommendations contained in this report. Section The Products That are the Subject of This Study - This section explains the four insurance products that we have studied. Section Affordability and Availability - In this section we present and define the issues of affordability and availability. Section Hard Market - In this section we discuss general reasons that lead to affordability and availability problems. CHAPTER 2 THE SITUATION IN NEWFOUNDLAND AND LABRADOR Section Historical Profitability of Homeowners Insurance, Commercial Property Insurance, Commercial Liability Insurance, and Marine Insurance - In this section we present the historical profitability for these insurance products in the province. Section Complaint Log - In this section we present information that we compiled from a review of the insurance complaint log maintained by the Department of Government Services. 2

6 Section Discussion With the Insurance Brokers Association of Newfoundland - In this section we present the thoughts and comments of representatives of IBAN regarding the market within the province for the four insurance products. Section Insurance Company Operations Within the Province - In this section we offer our comments, based on the information we have obtained and reviewed, as to whether insurance companies are operating reasonably within the province in accepting risks for the four insurance products, in relation to their profitability. CHAPTER 3 INSURANCE REGULATION Section Goals of Insurance Regulation - In this section we present the key reasons for government regulation. Section How Insurance is Regulated - In this section we present a general overview of insurance regulation. Section The Pros and Cons of Insurance Regulation - In this section we conclude our general discussion of insurance regulation by presenting some advantages and disadvantages of government regulation of insurance. CHAPTER 4 - WAYS TO ADDRESS AVAILABILITY AND AFFORDABILITY PROBLEMS Section Residual Market Mechanisms - In this section we identify several systems that have been established in other jurisdictions to provide insurance to risks that are not adequately serviced by the insurance industry. Section Additional Risk Spreading Mechanisms - In this section we present other alternative ways for transferring or financing insurance risk. 3

7 Section Other Ways to Deal With Availability and Affordability Problems - In this section we discuss two other ways that government can deal with the issues of availability and affordability. CHAPTER 5 RECOMMENDATIONS Section Recommendations - In this section we present our recommendations as to how the Government should address any availability or affordability problems that may exist. APPENDIX 1 DEFINITION OF KEY TERMS - This appendix is a convenient reference for those who are not familiar with the insurance terms we use in this report. APPENDIX 2 EXHIBITS - In this appendix we present various exhibits and graphs that supplement the information we present in the report. 1.2 Study Scope, Caveats, And Limitations This section contains what we generally designate as scope, caveats and limitations. These are items that define the boundaries of what we do and what we don t do in this study, and describe a number of elements and cautions that the reader should keep in mind while reading this report. The scope, caveats, and limitations listed below apply to our entire report. 4

8 General Scope The proper interpretation of this report, and the validity of any conclusions drawn from it, are highly dependent on a complete understanding of the scope of this project. The scope is defined in a number of ways, as discussed below. Distribution This report was prepared for the Government of. Permission is granted for the report to be distributed to other parties; however, the report must be distributed in its entirety. Data Reliance This analysis is based largely on aggregate insurance industry data for as compiled by the Office of the Superintendent from information presented in the P&C-1 and P&C- 2 reports prepared by insurance companies. We rely on the accuracy and completeness of this information. Insurance Products This report deals with four major insurance products. [In this report we also refer to these products as lines of insurance or insurance coverages.] The first is homeowners, which is reported as a part of the personal property line of insurance in the P&C-1 and P&C-2 reports, and not separately identified. Included in the personal property line of insurance are other insurance products such as tenants insurance and condominium insurance. The other three lines of insurance reviewed in this study are commercial property, commercial liability, and marine, each of which is reported as a separate line of insurance in the P&C-1 and P&C-2 reports. 5

9 Aggregates and Averages This analysis is based, in part, on experience of all insurance companies, and our findings regarding profitability are for all insurance companies, on average. Our conclusions may not be applicable to any specific insurance company. Provisions For Expenses, Investment Income, and Profit The assumptions that we make in this study regarding provisions for expenses, investment income, and profit are made for the purpose of measuring the historical profitability of the four insurance products. We believe our assumptions are reasonable for this purpose. The findings in this study should not be construed as recommendations for any specific level of insurance industry expenses or profits. Input by Stakeholders In developing our findings and recommendations, we reviewed the log of complaints made by consumers as compiled by the Department of Government Services, and discussed the current market availability and affordability issues with representatives of the Insurance Brokers Association of, who interact with insurers and consumers. 1.3 The Insurance Products That Are The Subject of This Study The wording (i.e., contractual obligation between the insurance company and insured) for the insurance products that are included in this study is not subject to legislative or regulatory requirements. As such, the actual products (i.e., what is insured and what is not insured) may vary from insurance company to insurance company. Homeowners Insurance Homeowners insurance combines real and personal property coverage with personal liability coverage. While the exact wording may vary by insurer, it generally provides insurance against damage to the home and its contents, as well as for the legal responsibility for any 6

10 injuries or property damage caused by the insured or household members to other people or property. The perils for which insurance coverage is provided are broad (e.g., fire, theft, wind, vandalism, etc.), but some perils may not be covered, such as earthquakes. There are also similar personal property policies tailored for tenants or condominium owners. Commercial Property Insurance Commercial property insurance is designed for commercial enterprises and professionals. While the exact wording may vary by insurer, it generally provides financial protection against the loss of, or damage to, real and personal property caused by a variety of perils, such as fire, lightening, business interruption, loss of rent/income, glass breakage, windstorm, water damage, and explosion. Commercial Liability Insurance Commercial liability insurance is also designed for commercial enterprises and professionals. While the exact wording may vary by insurer, it generally provides insurance coverage for the legal liability of the insured or insured s business resulting from damage to the property of others or personal injury to others. Some policies are primarily for liability coverage for manufactured products, while other policies are for professional liability coverage. Marine Insurance This insurance traditionally compensates both the owner and transportor of goods that are transported overseas (or via air) for losses due to maritime perils, which are defined as perils consequent on or incidental to navigation, including perils of the seas, fire, acts of pirates or thieves, captures, seizures, restraints and all other perils of a like kind Affordability And Availability Affordability of insurance generally refers to the financial ability, or willingness, of an individual or business to purchase desired or required insurance coverage that is otherwise available. 1 Marine Insurance Act, 1993, C. 22, Section 2. 7

11 Availability of insurance generally refers to the capacity and willingness of insurance companies to offer varying forms of insurance to consumers. Affordability and availability are relative concepts. Insurance that may be affordable to one individual or business may not be affordable to another individual or business. Insurance that is affordable one year may not be affordable some other year. Insurance that may be affordable in one jurisdiction may not be affordable in another jurisdiction. Availability of insurance is a function of the willingness of insurance companies to offer insurance coverage. What coverage one insurance company may be willing to offer may not be coverage that another insurance company may be willing to offer. Coverage that insurance companies offer in one year or in one jurisdiction may not be offered in another year or in another jurisdiction. Capacity is a function of both capital available and the extent of exposure that insurers are prepared to have, to risks that are offered to them to insure. Willingness to offer insurance is based upon the characteristics of the particular risk and whether the insurance company believes that the level of risk, as measured against the price it is charging or the reinsurance protections it may have in place, is acceptable to it. 2 Affordability and availability problems may arise independently or jointly. They may arise for an entire category of insurance coverage (e.g., property insurance, automobile insurance, medical malpractice insurance, etc.), for one particular type of risk (e.g., homes or motorcyclists), for one particular type of loss (e.g., flood, earthquake), or for a particular amount of insurance coverage (e.g., insurance on homes that exceed $500,000). 2 Effect of State Taxes on Insurance for Small Business, by Pete Rose and Geoff Atkins, Trowbridge Deloitte Limited, July

12 1.5 Hard Market When consumers have difficulty obtaining affordable insurance, or can t obtain insurance at all, the insurance market is generally referred to as a hard market. A hard market may be caused by any of a number of circumstances, including the following. Limited Market Competition Absent rate regulation, the existence of limited market competition provides one or a small number of insurance companies the power to charge unreasonably high premiums. Such a market condition is also characterized by a general lack of incentive for product innovation or desire to address consumer needs. Inability of Insurance Companies to Charge the Premiums Needed to Provide for Claim Payments, Operating Expenses, and a Reasonable Profit This situation may be caused by either unfair competitive practices or excessive governmental regulation. This often leads to the imposition of what is referred to as restrictive underwriting, a limitation in the type and amount of insurance coverage that is offered by insurance companies. Examples include restricting the types of insurance products sold, restricting the types of perils that will be insured, or restricting the insurance coverage offered to certain types of risks. Taken to an extreme, restrictive underwriting can lead to insurance companies withdrawing from a market. A Disconnect Between What Insurance Coverage is Desired and What Insurance Coverage is Offered This is often a temporary situation that is caused by a sudden demand for a type of insurance product that insurance companies have not yet fully developed. Identity theft insurance is an example of a relatively new insurance product. Insurance Company Reduced Profitability (or fear of reduced profitability) - This can be caused by a number of factors, many of which are inter-related, such as: decreased investment income A portion of an insurance company s revenue is derived from investment returns on policyholder premiums and company surplus. When interest rates decline, or stock prices fall, the amount of investment income earned by insurance companies declines. 9

13 inadequate insurance premiums The pricing of insurance products involves the estimation of future costs. To the extent those estimates of future costs are too low, or to the extent that insurance companies choose to charge less than the actuarially determined premium, profits will likely suffer. Future cost estimates may be too low for a number of reasons, including new laws or court rulings that result in unanticipated increases in the number or severity of insurance claims; an unanticipated increase in the claims consciousness of those that suffer injuries; unanticipated surges in inflation rates; newly arising perils that were not contemplated, such as oil leakage liability from home heating oil tanks; or other unanticipated environmental changes. As well, companies may choose to charge less than the actuarially based premium for several reasons, including the desire to maintain or increase market share. Catastrophes A single catastrophic event can significantly impair the insurance industry s surplus, and, hence, capacity to sell insurance. Insurance Company Insolvencies Insurance company insolvencies, for whatever reason, represent a financial burden on the insurance industry, and can lead to reduced profitability, and, hence, capacity to sell more insurance. Fraudulent Claims Fraud results in increased costs to insurance companies, which, in turn, can lead to reduced profitability and a reduced willingness to sell insurance. Concentration of Exposures Insurance companies may restrict their writings in a particular market or geographical area if they feel they have written more business than their capital or reinsurance programs can support. Unavailability of Reinsurance The purchase of reinsurance is an important way for insurance companies to spread their risk. Without reinsurance, insurance companies would likely decrease their writings in a market. 10

14 CHAPTER 2 The Situation in 2.1 Historical Profitability of Homeowners Insurance, Commercial Property Insurance, Commercial Liability Insurance, and Marine Insurance Introductory Comments Determining the historical profitability of insurance products and assessing whether the earned profits are reasonable is a two-step process. First, the amount of profits must be determined, and second, the profits must be measured against a standard of reasonableness. Insurance company profits are measured as the difference between revenue and costs. Insurance companies have three sources of revenue: the premium they charge and collect for the insurance coverage they provide; the investment income they earn on the premiums they collect; and the investment income they earn on the surplus that they carry. Insurance companies incur two types of costs: the payments they make, or are expected to make, for claims filed by their insureds (hereafter we refer to these claim costs, which include both indemnification costs and claim settlement costs, as losses); and the operating expenses (e.g., salaries, commissions, marketing costs, etc.) that they incur. 11

15 Therefore, in order to determine the historical profits of each of the four insurance products in the province, we add the three components of revenue to get total revenue, add the two components of costs to get total costs, and then subtract total costs from total revenue. We do this by year, and for each of the four insurance products. There are two basic sources of information for insurance company premium revenue and losses for the personal property, commercial property, commercial liability, and marine insurance products. One is the mandatory annual return, referred to as the P&C-1 or P&C-2, in which the premiums earned and losses incurred by insurance companies are provided by calendar year for each of these products. The second is the loss experience exhibits compiled by the Insurance Bureau of Canada (IBC) under the Personal Lines Statistical Plan, Commercial Lines Statistical Plan, and the Liability Statistical Plan. However, these IBC exhibits do not include the experience of all insurance companies, as insurance companies are not required to submit this information to IBC. Hence, the IBC reports do not provide a complete representation of premium revenue and losses in the province. For our calculation of premium revenue and losses, we rely upon the data compiled by the Office of the Superintendent from information presented in the annual returns, P&C-1 reports, prepared by each insurance company licensed (federally or provincially) in. Unfortunately, there is no source of published information on the expenses of insurance companies selling these four insurance products in. Therefore, we make an assumption as to the average amount of expenses incurred by insurance companies for each of the four insurance products. We state the assumed average expense cost as a percentage of the premiums earned by insurance companies, and the percentage we select is based on the following considerations and assumptions. that insurance companies that sell insurance through brokers pay an average commission rate of 20% of premium, plus a contingent commission that typically ranges from 1% to 3% of premium; that direct writer insurers (i.e., insurance companies that do not use brokers, but instead, use salaried staff to sell their products), would have substantially lower business acquisition costs than companies that sell through brokers; 12

16 that insurance companies pay a premium tax equal to 4% of premium; that costs for licenses and fees are approximately 1% of premium; and that other operating expense costs range from 8% to 12% of premium. Based on these considerations, we select an average expense cost of 35% of premium for each product. That is, we assume that for every $100 of premium that an insurance company earns, $35 would be paid out in operating expenses. We believe this to be a reasonable assumption for all insurance companies, on average, but recognize that some insurance companies may have lower expense costs and some may have higher expense costs. Determining a precise standard of profit reasonableness, which will vary over time as economic conditions change, is a matter for economists to determine, and, thus, is outside the scope of this study. However, 5% of premium is a generally accepted rule of thumb standard for profit reasonableness, and we accept this as the standard against which we measure average profit reasonableness in this study. The selected expense cost of 35% of premium and the selected profit level of 5% of premium mean that 60% of premium (i.e., 100% less 35% less 5%) is the level of losses against which we measure profitability. As respects the investment income earned by insurance companies, we assume that any investment income earned on company surplus is implicitly reflected in our profit reasonableness standard. As respects the investment income earned by insurance companies on the premiums they receive (often referred to as the investment income on cash flow) we assume for the homeowners product and the commercial property product that this is relatively minimal as expenses and losses are paid relatively quickly and there is little opportunity for insurance companies to earn income on the investment of the premium. 13

17 But, unlike the property lines of business, the claims that occur under the commercial liability and marine products often take many years to settle. As a result there is a much greater opportunity for insurance companies to earn investment income on the premium that is collected until it is used to pay losses or operating expenses. While specific data for the average time period it takes to settle and fully pay commercial liability or marine losses and expenses is not available to us for, based on our experience and judgement, we estimate the average time period is 5 years. Assuming insurance companies can earn investment income on their cash flow at a rate of 5% per annum, the current value of $1 in future settled claim payments is approximately $0.77. Based on these claim settlement and investment rate assumptions, a 78% loss ratio for commercial liability or marine insurance is financially equivalent to a 60% loss ratio for homeowners or commercial property insurance (.77x 78%=60%). Therefore, whereas a 60% loss ratio is the profit reasonableness standard we select for homeowners and commercial property insurance, our selected standard for commercial liability and marine insurance is 78%. Our assumed expense cost of 35% of premium, and our assumed reasonable profit level of 5% of premium, implies that if insurance companies had a level of losses that equalled 60% of premium (78% for commercial liability and marine), they would have achieved a reasonable level of profits. If insurance companies had a level of losses that exceeded 60% (or 78%) of premium, they would have achieved less than a reasonable level of profits (or possibly have incurred a loss). If insurance companies had a level of losses that was less than 60% (or 78%) of premium, they would have achieved an excessive level of profits. Note, hereafter we refer to the amount of losses as a percent of premium, as the loss ratio. Hence, a historical loss ratio of 60% (or 78%) implies a reasonable profit, a loss ratio in excess of 60% (or 78%) implies less than a reasonable profit, and a loss ratio less than 60% (or 78%) implies more than a reasonable profit. 14

18 We now present our findings as regards the historical profitability of these four insurance products in the province, based on the 60% and 78% loss ratio profit reasonableness standards we have selected. Homeowners As noted above, information for the homeowners product is not shown separately in the P&C-1 reports. Rather, the information for the homeowners product is combined with the information for other forms of personal property insurance, such as fire insurance policies. However, the homeowners product represents the majority of the personal property category of insurance. We reviewed the loss ratio history of all insurance companies that wrote personal property insurance in the province over the 10-year period, The average loss ratio over the 10-year period was 46%, which is 14 percentage points less than the 60% loss ratio standard of reasonableness. This means that based on our standard, insurance companies have made, on average, a profit of 19% 3 of premium over the last 10 years (100%-46%-35%). This is nearly four times our standard of profit reasonableness of 5% of premium. The loss ratio over this 10-year period was highest in 2001 at 85%, but was within the range of 33%- 52% for the remaining 9 years. With the exception of 2001, the results for all years were well below the 60% loss ratio threshold target we have assumed. The following chart provides a range of estimated profit levels, based the loss ratio history and the expense ratio assumption of 35%. 3 Based on a premium to surplus ratio of 2 to 1, an investment income rate on surplus of 5%, and an income tax rate of 36%, a profit margin of 19% implies the (after-tax) return on equity is 28%. 15

19 Calendar Year Loss Ratio Estimated Profit Margin % 16% % 24% % 24% % 33% % 32% % 29% % 27% % 13% % -20% % 16% Average Last 10 Years 46% 19% Average Last 5 Years 52% 13% As can be seen from the above chart, insurance companies, on average, have experienced very profitable results for personal property insurance every year over the last ten years except Based on anecdotal information, we assume the relatively high loss ratio for 2001 is due to the unusually large snowfall that occurred that year. [The great amount of snow could have been the cause of leaks in the outdoor oil tanks. Also, the melting of the large quantity of snow caused flooding, which in turn, may have caused damage to property.] While it appears that insurance companies, as a whole, have experienced generally profitable results for personal property insurance over the last 10 years, we cannot say that all insurance companies realized profitable results. Nor can we say that personal property insurance has been profitable in all areas of the province and for all types of property. The following chart shows the year over year percentage change in the total (written) premiums for personal property insurance in the province between 1993 and

20 Calendar Year Written Premiums in 'ooos Annual Percentage Change , , % , % , % , % , % , % , % , % , % Average 3.7% The above changes may be as a result of (1) the increase in new homes or dwellings in the province, (2) rate increases imposed by insurers to compensate for higher cost of claims, and/or (3) premium increases imposed by insurers to reflect the higher values of dwellings due to inflationary forces. The average annual change over the 10-year period is 3.7%. Although we cannot say for certain (because we don t have the information separately by each of these three components of premium change), it would appear, based on the 3.7% average annual premium change, that rate increases have been relatively modest over the ten years. We note, however, that the 2002 increase over 2001 was 10.8%. This suggests that, in general, insurance companies reacted to the relatively high loss ratio experienced in 2001 with relatively high rate increases during the 2002 year. Unfortunately, we cannot determine from this information whether there were certain areas within the province, or some specific types of risks within the province, that experienced much larger than average rate increases over this period. In summary, based on the standards we have selected, it appears that the homeowners insurance product has been very profitable for insurance companies in the province over the past 10 years. Seemingly, a relatively large increase in rates was experienced in the period following the one bad year that insurance companies, as a whole, suffered. 17

21 In Appendix 2 we present, graphically, the historical personal property loss ratios and premium for all companies combined. Commercial Property We reviewed the loss ratio history of all insurance companies writing commercial property insurance (i.e., for retail stores, commercial buildings, etc.) in the province over the 10-year period, The average loss ratio over the 10-year period was 63%, which is 3 percentage points more than the 60% loss ratio standard of reasonableness. This means that based on our standard, insurance companies, on average, have experienced somewhat less than reasonable profits over the last 10 years. The loss ratios over this 10-year period ranged from a high in 1994 at 103%, to a low of 30% in There is considerable year-to-year volatility in the loss ratio experience, with only 6 of the last 10 years at or below the 60% loss ratio standard. The following chart provides a range of estimated profit levels, based the loss ratio history and the expense ratio assumption of 35%. 18

22 Calendar Year Loss Ratio Estimated Profit Margin % -6% % -38% % 2% % 18% % 35% % 18% % -38% % 9% % 6% % 13% Average Last 10 Years 63% 2% Average Last 5 Years 63% 2% As can be seen from the chart above, insurance companies, on average, have not experienced a reasonable level of profit over this 10-year period, and the results have fluctuated from year to year. Based on the 60% loss ratio standard, insurance companies, on average, have experienced profits in 7 of the last 10 years ( ). And in 1 of those 7 years, the level of profit was less than the 5% reasonableness standard. Seemingly, however, while the insurance companies as a whole have experienced somewhat less than reasonable profits over the 10-year period, we cannot conclude that all insurance companies experienced the same financial results, or that this experience was realized for all locations or businesses within the province. There may very well have been some insurance companies, or some locations or businesses that had very different loss ratio experience. The following chart shows the year over year percentage change in the total (written) premiums for commercial property insurance in the province between 1993 and

23 Calendar Year Written Premiums in 'ooos Annual Percentage Change , , % , % , % , % , % , % , % , % , % Average 8.2% These changes in total industry premiums may be as a result of (1) a net increase of new commercial enterprises in the province, (2) rate increases imposed by insurers to compensate for higher cost of claims, and/or (3) premium increases imposed by insurers to reflect the higher values of the commercial property due to inflationary forces. The average annual premium change over the 10-year period is 8.2%; on a compounded basis, the average annual premium change has been approximately 5% per year. As shown in the above chart, the year over year change has ranged from a 38% decrease to a 46% increase. Further, while the average over the 10-year period is under 10%, the purchasers of commercial property insurance have experienced double-digit changes in their premiums - either up or down - since This volatility in premium may make it difficult for businesses to achieve operating plans and likely raises concerns about the future availability or affordability of commercial property insurance. Unfortunately, we cannot determine from this information whether there were certain areas within the province, or some specific types of risks within the province, that experienced much larger than average rate increases over this period. In summary, the commercial property insurance loss experience has fluctuated widely over the last 10 years. Based on the standard we have selected, it appears, in general, that the commercial property insurance product has been, on average, less than reasonably profitable for insurance companies in the province over the past 10 years. While the annual change in written premiums has 20

24 been both volatile and relatively large, the compounded annual rate of change in premiums is only 5%. In Appendix 2 we present, graphically, the historical commercial property loss ratios and premium for all companies combined. Commercial Liability We reviewed the loss ratio history of all insurance companies that wrote commercial liability insurance in the province over the 10-year period, The average loss ratio over the 10- year period was 81%, which is 3 percentage points more than the 78% loss ratio standard of reasonableness. This means that based on our standard, insurance companies, on average, have experienced somewhat less than reasonable profits over the last 10 years. The loss ratio over this period ranged from a high in 1997 at 120% to a low of 40% in There is a considerable amount of year-to-year fluctuation in the loss ratio experience. The following chart provides a range of estimated profit margins, based on the loss ratio history and the expense ratio assumption of 35%. 21

25 Calendar Year Loss Ratio Discounted Loss Ratio Estimated Profit Margin % 77% -12% % 47% 18% % 43% 22% % 61% 4% % 92% -27% % 53% 12% % 88% -23% % 65% 0% % 68% -3% % 31% 34% Average Last 10 Years 81% 63% 2% Average Last 5 Years 79% 61% 4% As can be seen from the chart above, insurance companies, on average, have experienced financial results for the commercial liability product that have fluctuated considerably over the 10-year period. Based on our loss ratio standard and expense assumptions, insurance companies, on average, have realized profits in 5 of the last 10 years, and have experienced a financial loss in 4 of the other 5 years. While it appears that insurance companies, as a whole, have not realized reasonable profits for liability over the 10-year period, we cannot say that no insurance company realized reasonable or excessive profits over this period. Nor can we say that the commercial liability product has not been profitable for insurance companies in all markets within the province. The following chart shows the year over year percentage change in the total (written) premiums liability in the province between 1993 and

26 Calendar Year Written Premiums in 'ooos Annual Percentage Change , , % , % , % , % , % , % , % , % , % Average 13.6% The above changes may be as a result of (1) a net increase of new commercial enterprises in the province, (2) rate increases imposed by insurance companies to compensate for higher cost of claims, and/or (3) higher limits of coverage purchased by some insureds due to inflationary forces or business requirements. The average annual change over the 10-year period is 13.6%; however, as shown in the above chart, the year over year change has ranged from a 6.4% decrease to a 38.9% increase. This volatility in premium may make it difficult for businesses to achieve operating plans and likely raises concerns about the future availability or affordability of commercial liability insurance. We cannot determine from this information whether there were certain markets within the province that experienced much larger than average rate increases over this period. In summary, based on the standards we have selected, it appears that the commercial liability insurance product has been, on average, less than reasonably profitable, over the last 10 years. The annual change in written premiums has been both volatile and large. From 1993 to 2002, the compounded annual rate of change in premiums is approximately 11%. In Appendix 2 we present, graphically, the historical commercial liability loss ratios and premium for all companies combined. 23

27 Marine We reviewed the loss ratio history for marine insurance in the province over the 10-year period, The average loss ratio over the 10-year period was 144%, which is 66 percentage points more than the 78% loss ratio standard of reasonableness. This means that based on our standard, insurance companies have experienced very unprofitable results over the last 10 years. The loss ratio over this period ranged from a high in 2002 at 270% to a low of 4% in There is considerable year-to-year volatility in the loss ratio experience, significantly more than the other three products. The following chart provides a range of estimated profit margins, based on the loss ratio history and the expense ratio assumption of 35%. Calendar Year Loss Ratio Discounted Loss Ratio Estimated Profit Margin % 148% -83% % 87% -22% % 66% -1% % 138% -73% % 3% 62% % 27% 38% % 169% -104% % 143% -78% % 123% -58% % 208% -143% Average Last 10 Years 144% 111% -46% Average Last 5 Years 174% 134% -69% As can be seen from the chart above, insurance companies, on average, have not experienced profitable results for the marine insurance product over the 10-year period. Based on our loss ratio 24

28 standard and expense assumptions, insurance companies, on average, have realized profits in 2 of the last 10 years, and have experienced significant financial loss in the other 8 years. The following chart shows the year over year percentage change in the total (written) premiums in the province between 1993 and Calendar Year Written Premiums in 'ooos Annual Percentage Change , , % , % , % ,433 na ,168 na , % , % , % , % Average 28.7% The average annual change over the 10-year period is 28.7%; excluding the 1997 written premium from this average which is an unusual year. However, as shown in the above chart, the year over year change has ranged from a 58% decrease to a 77% increase. This volatility in premium may make it difficult for businesses to achieve operating plans and likely raises concerns about the future availability or affordability of marine insurance. In summary, based on the standards we have selected, it appears that insurance companies writing marine insurance have experienced, on average, widely fluctuating and largely unprofitable results over the past 10 years. The annual change in written premiums has been both volatile and large. In Appendix 2 we present, graphically, the historical marine loss ratios and premium for all companies combined. 25

29 2.2 Complaint Log We have reviewed the insurance complaint log that we were provided. following: Our review reveals the while a large majority of the complaints involve homeowner insurance, concern on commercial insurance has been increasing homeowner complaints in the downtown area of St. Johns are common homeowner complaints mention oil tanks as part of the problem in obtaining insurance a majority of the homeowner complaints involve insurance that was either cancelled, not renewed, or that seemed unavailable commercial complaints concerning insurance for a bar (re: liquor liability) is common while a relatively small percentage of the homeowners complaints mention rates as a concern, almost half of the commercial complaints deal with rates 26

30 2.3 Discussion with the Insurance Brokers Association of Newfoundland (IBAN) We interviewed IBAN spokespersons Mr. D. Swain and Mr. J. Legrow, who provided their perspectives of the current affordability and availability issues in the province, and who offered ways in which the brokers are helping to minimize these problems for consumers. A summary of their comments follows. Personal Property In general, most consumers have been able to find affordable personal property insurance in the province, with annual rate increases well within the single digit range. However, for certain locations and certain types of risks, consumers have experienced problems finding insurance. In general theses risks are substandard; for example, they may lack recent updates to electrical wiring. A more common problem is the availability of insurance in the downtown areas. From IBAN s perspective, it would appear that the downtown locations are less desirable to insurance companies for a combination of reasons: (1) insurance companies wishing to avoid an over concentration in one area, (2) proximity of adjacent sub-standard risks, and (3) substandard dwellings without recent updates. The insurance broker community has been working with the Office of the Superintendent of Insurance to find insurance for those risks unable to find insurance. Individual consumers that contacted the Office of the Superintendent were forwarded to IBAN. The broker community has been placing insurance for such orphaned risks through their insurance companies. In addition, several insurance companies have provided a sub-standard market for these personal property risks and have thus contributed to the solution to the personal property insurance availability issue. IBAN estimates that 30 risks were presented by the Superintendents Office to IBAN for special placement. Of these, only 2 were not offered insurance by the insurance companies. In one case, this was due to safety concerns, and in the other case, this was due to past claims problems. 27

31 Commercial Property and Liability IBAN suggests there have been more affordability and availability problems in the commercial property and liability lines of business than in the personal property line of business. In general, IBAN estimates that annual rate increase have been in the 10% to 25% range - and often higher - making affordability an issue for many businesses. Some commercial businesses that traditionally have been difficult for insurance brokers to place, such as those with liquor liability exposure, have experienced very large rate increases. In many cases, even if the risk has very good loss control measures in place and no history of losses, large rate increase have been imposed. In some cases, certain risks have been unable to find affordable insurance to make their business enterprise feasible. Examples related to adventure tourism and snow plow operators were cited. The lack of available and/or affordable insurance has become an economic hurdle for certain businesses in the province. In the past, when the regular market insurers had exhausted their capacity or willingness to accept a commercial risk, the insurance broker would be able to place the risk through specialty lines writers. These specialty lines writers would act as the conduit between the broker and insurance companies, finding insurance markets for large or difficult commercial risks. However, for the first time, IBAN is finding even these specialty writers will not accept these unwanted risks at any price. Based on discussions IBAN has had with insurers, it expects the commercial insurance market to improve in 2004, with rates stabilizing and an increased acceptance of substandard risks. 28

32 2.4 Insurance Company Operations within the Province From our analysis of the reported loss experience, our review of the complaint log, and our discussion with IBAN, we draw the following high-level conclusions about insurance company operations within the province. Homeowners Homeowners (personal property) is the only insurance product where there is evidence that insurance companies, in total, may have realized excessive profits over the past ten years. Up until the 2002 year, average annual rate increases were seemingly modest. But in 2001 insurance companies suffered their first unprofitable year. The premium information and complaint log suggest that companies reacted to the 2001 experience by increasing rates more than normal, and by tightening up on underwriting particularly in the downtown areas and homes with oil tanks. However, perhaps due to the cooperative efforts of the Superintendent s Office, IBAN, and the insurance companies, there doesn t appear to be a serious availability or affordability problem with this product. As respects oil tanks, we note the following: 1.) As the old tanks age, they rust (more often from the inside, which is why visual inspections are not effective) and can leak. The very major expense of environmental cleanup from this occurrence, while covered under the homeowners policy, is not contemplated in the rates, as such losses have not occurred in the past. While newer tanks are double-walled, older tanks were not. They are only now becoming old enough to rust and leak. 2.) The snowstorms of 2001, with the heavy weight of snow on unprotected tanks, and subsequent freezing and thawing, may have weakened tanks further, causing leakage and bringing this potential loss situation to the attention of insurers. 29

33 In the Recommendations section of this report, we suggest ways in which the Government can further address issues concerning homeowners. Commercial Property Commercial property has been less profitable than homeowners over the past 10 years, and the profits have not been excessive. Despite relatively favourable results in each of the years 2000, 2001, and 2002, there is evidence of relatively large rate increases in 2001 and We suspect that any availability or affordability problems that commercial businesses may have primarily stem from the commercial liability exposure. In the Recommendations section of this report, we suggest ways in which the Government can further address issues concerning commercial property. Commercial Liability Commercial liability has been less than profitable for insurance companies over the past 10 years, and the experience is marked by large fluctuations. Companies suffered financial losses in 2001, and like for the homeowners product, seemingly responded by sharply increasing rates and tightening up underwriting. The risks that have been the most affected by these actions are those with a liquor liability exposure, those involved with tourism, and snow plow operators. In the Recommendations section of this report, we suggest ways in which the Government can further address issues concerning commercial liability. Marine It is difficult for us to reach even high-level conclusions about the marine insurance product. The reported experience suggests that this has been a very unprofitable product for insurance companies, but we have no information to understand why this is the case. Premium volume has fluctuated widely over the years, but the cause is not clear. And there are no complaints that deal with this product. 30

34 We offer some comments on this product in the Recommendations section. 31

35 CHAPTER 3 Insurance Regulation 3.1 Goals of Insurance Regulation Government has the full power and authority to make, constitute and ordain Laws, Statutes, and Ordinances, for the public welfare and good government. 4 In the specific area of insurance, the generally recognized goals of governmental regulation are to ensure that: the cost of insurance is affordable for those requiring insurance necessary insurance is available for the those requiring insurance insurance companies are financially able to deliver on their contractual obligations to provide insurance coverage for future events insurance companies comply with insurance laws and regulations fraud and abuse by both insurance companies and insureds are controlled. In short, the primary goal of insurance regulation is to protect the consumer, whether the consumer is an individual or a business. There is, however, in Canada (and in other countries), an additional goal of insurance regulation: the creation and enforcement of laws and regulations (such as anti-trust laws) to... maintain and encourage competition in Canada in order to provide consumers with competitive prices and 4 Royal Instructions to Governor Darling,